18.1 Finance
18.1.1 Return on Investment (ROI)
\[ ROI = \frac{\text{Net Profit}}{\text{Investment}} \]
Similarly, return on marketing investment
\[ ROIM = \frac{IRAM - CM}{MS} \]
where
- IRAM = Incremental Revenue Attributable to Marketing
- CM = Cost of the Marketing Investment
- MS = Marketing Spending
If ROMI is positive, then firm is on doing well.
18.1.2 Economic Value Added
- also known as economic profit.
- is a measure based on the residual wealth calculated by deducting its cost of capital from its operating profit, adjusted for taxes on a cash basis.
- measures the value a company generates from its invested funds.
- EVA relies heavily on invested capital. Hence, more suitable for asset-rich companies, whereas companies with intangible assets, such as technology businesses, may not be good candidates.
\[ EVA = NOPAT - (Invested Capital * WACC) \]
where
NOPAT = Net Operating profit after taxes = Operating Profit x (1-Tax Rate)
Invested capital = Debt + capital leases + shareholders’ equity = Equity + long-term debt at the beginning of the period
WACC = Weighted average cost of capital (average rate of return a company expects to pay its investors).
\(WACC = \frac{Ke \times E}{E+D} + \frac{Kd \times (1-t) \times D}{E +D }\)
- Ke = required return on equity
- Kd(1-t) = after tax return on debt.
(WACC* capital invested) is also known as a finance charge
Invested capital can also be calculated as (Total Assets - Current Liabilities). Hence, the modified version of EVA is:
\[ EVA = NOPAT - (\text{total assets} - \text{current liabilities}) * WACC \]
18.1.3 Market Value Added
- is the amount of wealth that a company is able to create for its stakeholders since its foundation.
- (the current market value of the company’s stock - the initial invested capital)
\[ MVA = \text{market value of shares (or enterprise value)} - \text{book value of shareholders' equity} \]
18.1.4 Unexpected size-adjusted advertising investments
(Chakravarty and Grewal 2016; MinChung Kim and McAlister 2011; Yan Liu, Shankar, and Yun 2017) used
18.1.6 Profitability
(Grewal et al. 2008; McAlister et al. 2016)
\[ \text{profitability} = \frac{\text{operating income before depreciation}}{\text{total assets}} \]
18.1.7 Firm Size
(Grewal, Chandrashekaran, and Citrin 2010; McAlister et al. 2016; Nezami, Worm, and Palmatier 2018) used log of total asset in million as firm size
\[ \text{firm size} = \log (\text{total assets}) \]
18.1.8 Sales Growth
(Grewal, Chandrashekaran, and Citrin 2010; Nezami, Worm, and Palmatier 2018; V. R. Rao, Agarwal, and Dahlhoff 2004)
Percentage change in gross sales = sales growth
18.1.10 Cash flows
(Chakravarty and Grewal 2011; Malshe and Agarwal 2015) Cash flows = log(operating cash flow in mil)
18.1.11 Financial Leverage
(Kashmiri and Mahajan 2017; Chakravarty and Grewal 2011)
\[ \text{financial leverage} = \frac{\text{long-term debt}}{\text{book value of assets}} \]
18.1.12 Stock return
(Markovitch, Steckel, and Yeung 2005; Chakravarty and Grewal 2011, 2016) used dummy if stock returns exceed industry averaged stock returns
18.1.14 Book Equity
Following Fama and French’s definition:
“BE is the book value of stockholders’ equity, plus balance sheet deferred taxes and investment tax credit (if available), minus the book value of preferred stock. Depending on availability, we use the redemption, liquidation, or par value (in that order) to estimate the book value of preferred stock. Stockholders’ equity is the value reported by Moody’s or Compustat, if it is available. If not, we measure stockholders’ equity as the book value of common equity plus the par value of preferred stock, or the book value of assets minus total liabilities (in that order)” (cite (Davis, Fama, and French 2000))
18.1.15 Net Contribution
Net contribution = gross margin x sales - cost of marketing
\[ NC = m \times S(a) -ka \]
| Variable | Data Item | Source |
|---|---|---|
| Book Value on Equity | PRCC_C x CSHO | PRCC_C: CRSP/Annual Update/CRSP/Compustat Merged/Fundamental Annual/Supplemental Data Items CSHO: CRSP/Annual Update/CRSP/Compustat Merged/Fundamental Annual /Miscellaneous Items |
| CAPEX | CAPX | Cash Flow Items |
| Capital Intensity | CAPX / AT | CAPX: Cash Flow Items AT: Balance Sheet Items |
| Cash | CH | Balance Sheet Items |
| Cash and short-term Investments | CHE | Balance Sheet Items |
| Cash Flow | \(\frac{IBC + DP}{AT}\) | IBC: Cash Flow Items DP: Income Statement Items AT: Balance Sheet Items |
| Cash Holdings | \(\frac{CHE}{AT}\) | CHE: Balance Sheet Items AT: Balance Sheet Items |
| Closing Price (annual, calendar) | PRCC_C | Supplement Data Items |
Closing Price (annual, fiscal) |
PRCC_F | Supplement Data Items |
| Cost of Capital | \(\frac{XINT}{DLC}\) | XINT: Income Statement Items DLC: Balance Sheet Items |
| Current Assets Total | ACT | Balance Sheet Items |
| Current Liabilities | LCT | Balance Sheet Items |
| Debt in Current Liabilities | DLC | Balance Sheet Items |
| Dividends (common) | DVC | Income Statement Items |
| Dividends (preferred) | DVP | Income Statement Items |
| Dividends (total) | DVT | Income Statement Items |
| Earning per Shares | \(\frac{NI}{CSHO}\) | NI: Income Statement Items CSHO: Miscellaneous Items |
| EBIT | EBIT | Income Statement Items |
| EBITDA | EBITDA | Income Statement Items |
| Equity Book Value | BKVLPS | Balance Sheet Items |
| Firm Size | log(AT) | AT: Balance Sheet Items |
| Income before Extraordinary Items | IB | Income Statement Items |
| Interest on long-term debt | UXINTD | Income Statement Items |
| Interest on short-term Debt | UXINST | Income Statement Items |
| Leverage | \(\frac{DLTT + DLC}{SEQ}\) | Balance Sheet Items |
| Long-term Assets | AT - ATC | Balance Sheet Items |
| Long-term Debts | DLTT | Balance Sheet Items |
| Market to Book Ratio | \(\frac{MKVALT}{BKVLPS}\) | MKVALT: Supplement Data Items BKVLPS: Balance Sheet Items |
| Market Value | MKVALT or CSHO x PRCC_F | MKVALT: Supplement Data Items CSHO: Miscellaneous Items PRCC_F: Supplement Data Items |
| Net income (Loss) | NI | Income Statement Items |
| Payout Ratio | \(\frac{DVP + DVC + PRSTKC}{IB}\) | DVP: Income Statement Items DVC: Income Statement Items PRSTKC: Cash Flow Items IB: Income Statement Items |
| Property, Plant, and Equipment | PPENT | Balance Sheet Items |
| Purchase of common and preferred Stocks | PRSTKC | Cash Flow Items |
| R&D Intensity | \(\frac{XRD}{AT}\) | XRD: Income Statement Items AT: Balance Sheet Items |
| ROA | \(\frac{NI}{AT}\) | NI: Income Statement Items AT: Balance Sheet Items |
| ROE | NI/(CSHO x PRCC_F) | NI: Income Statement Items CSHO: Miscellaneous Items PRCC_F: Supplement Data Items |
| ROI | \(\frac{NI}{ICAPT}\) | NI: Income Statement Items ICAPT: Balance Sheet Items |
| Sale | SALE | Income Statement Items |
| Short-term Liabilities | APC | Balance Sheet Items |
| Stockholders Equity (total) | SEQ | Balance Sheet Items |
| Tangibility | \(\frac{PPENT}{AT}\) | PPENT: Balance Sheet Items AT: Balance Sheet Items |
| Tobin’s Q | \[AT + (CSHO x PRCC_F) - CEQ\]/(AT) | AT: Balance Sheet Items CSHO: Miscellaneous Items PRCC_F Supplement Data Items CEQ: Balance Sheet Items |
| Total Assets | AT | Balance Sheet Items |
| Total Equity | PSTKC + CSHO | PSTKC: Balance Sheet Items CSHO: Miscellaneous Items |
| Total Liabilities | LT | Balance Sheet Items |
Information is taken from WRDS Data Items
| Variable | Data Item | Data Source |
|---|---|---|
| Age | CRSP | |
| Valuation | ||
| Market Cap/ GDP | series GDPA (U.S. Bureau of Economic Analysis) | |
| Tobin’s q | (AT (CSHO * PRCC_F) - CEQ)/(AT) | |
| Market cap (000s) | \(prc \times shrout\) | CRSP |
| Small firm | Market cap < $ 100M | |
Revenue Herfindahl (for each 3-digit NAICS in each year) |
\(\frac{revt^2_i}{\sum_1^n revt}\) where \(i\) = the firm, \(n\) = firms in the same industry | |
| Investment | ||
| Capital Expenditures / Assets | \(\frac{capx}{lag(at)}\) | |
| R&D/Assets | \(\frac{xrd}{lag(at)}\) | If R&D is missing, set to 0 |
| Fixed Assets/ Assets | \(\frac{ppent}{at}\) | |
| Inventory / Assets | \(\frac{invt}{at}\) | |
| Cash / Assets | \(\frac{che}{at}\) | |
| Profitability | ||
| Operating cashflow / assets | \(\frac{oidbp - xint - txt}{lag(at)}\) | Operating income before depreciation (oibdp) minus interest (xint) minus taxes (txt), divided by lagged assets |
| Loss firms | % of firm with net income (ni) < 0 | |
| R&D-adjusted operating cash flow/ assets | \(CF/at + RD/ at\) | |
| ROA | \(\frac{ib}{at}\) | |
| Financing | ||
| Book Leverage | \(\frac{dltt + dlc}{at}\) | |
| Market leverage | (dltt + dlc)/(at - ceq + (chso x prcc_f) | |
| Net Leverage | \(\frac{dltt + dlc - che}{aat}\) | |
| Negative net leverage firms | % of firms with Net Leverage < 0 | |
| Interest/ Assets | \(\frac{xint}{lag(at)}\) | |
| No debt firms | % with no dltt or dlc | |
| Net equity issuance | \(\frac{sstk - prstkc}{lag(at)}\) | |
| Ownership | ||
| Institutional ownership | % of shares outstanding held by institution | Thomson Financial 13f data |
| Blockholder | % of firms with an institutional owner who holds 10 percent or more of outstanding shares | Thomson Financial 13f data |
| Payout Policy | ||
| Dividend paying firms | % of firms with dvc > 0 | |
| Dividends / Assets | \(\frac{dvc}{lag(at)}\) | |
| Repurchase / Assets | \(\frac{prstkc - pstk}{lag(at)}\) | |
| Total payout/ assets | \(\frac{dvc + prstkc}{lag(at)}\) | |
| Total payout/ Net income | \(\frac{dvc+ prstkc}{ni}\) |
Info from (Kahle and Stulz 2017) Appendix